Hedge Fund Replication Strategies: A Comparison

by: AlphaClone

There were a few articles in the financial press this week referencing a new study on hedge fund replication strategies. The study finds that many of the hedge fund replication products recently introduced by large banks such as Barclays and Goldman Sachs have done relatively well over the recent market downturn. The study, entitled “How Do Hedge Fund Clones Manage the Real World” by Tuchschmid, Wallerstein, Zaker, compares the return characteristics for several hedge fund replication products against several benchmark indexes from March 2008 to May 2009. Here are the results: [ images]

As you can see from the table above, of the 21 replication products analyzed, the top 13 or so did well against the S&P500 and several other hedge fund indexes. When you consider that these products are being offered for a 1% to 2% fee instead of 2/20 for a traditional hedge fund or even 3/30 for a Fund of Funds – it’s no wonder money is flowing rapidly into them.

But what are you really getting with these kinds of hedge fund clones? These type of clone products are designed to mimic the average performance within the entire universe of funds tracked by their benchmark index. Measured over a longer period of time, the average performance embodied in hedge fund indexes doesn’t really impress:
Hf index performance

[Source: Hedge Fund Research]

…and the “investable” versions perform even worse:


[Source: Hedge Fund Research]

Wouldn’t you rather just clone the top performing funds in the group? Rather than settle for the “beta” within the entire universe, why not search for the “alpha” in the group? That gets you all the benefits that come with cloning such as low fees, liquidity and transparency but with the added upside in performance, better tax management from holding actual stocks and complete model transparency.

We thought it would be interesting to rank a couple of AlphaClone portfolios against the performance numbers above. We compared two sets of our clones to both the factor-based cloning products summarized in the study and their respective benchmarks. We chose the Hedge Fund Index Top Holding Clone because we think it is a good representative of the hedge fund intelligence in our database. We also chose the Value Masters Top 20 Popularity Clone because we think that the underlying group of value managers is a good example of funds that tend to clone “well”. Here are the top 10 clones from the study, this time displayed against our clones:


It’s not even a contest!